Market Pleasantly Distracted by Earnings

10/05/2011 3:21 pm EST

Focus: MARKETS

Jim Jubak

Founder and Editor, JubakPicks.com

Today, the US stock market is paying attention to sectors. Technology is up. Financials are down.

I think that’s good news for investors are we head into earnings season, with Alcoa (AA) kicking off third-quarter reports after the close next Tuesday, October 11.

Today as of 2:30 p.m. New York time, the Technology Select Sector SPDR (XLK) is up 1.9%. That performance is a major reason that the technology-heavy NASDAQ Composite, up 1.69%, is outperforming the S&P 500 and the Dow today.

The Financial Select Sector SPDR (XLF), on the other hand, is headed in the other direction, down 0.2% today.

So why is today’s performance by these two sectors good news? Because it shows that investors might be able to push fear to the side for long enough to pay attention to earnings for the next few weeks.

I expect financial stocks to deliver disappointing earnings for the third quarter and for technology stocks to surprise to the upside.For that to turn into actual movements in stock prices, though, investors have to actually pay attention to the results.

Big banks are looking at hits to earnings coming at them from every direction. The flatter yield curve engineered by the Federal Reserve’s efforts to lower long-term interest rates will cost banks such as Northern Trust (NTRS), State Street (STT), and Bank of New York-Mellon (BK) 3% to 4% from earnings in the third quarter, Sanford Bernstein Research estimates.

Meanwhile, global deal flow is down, and that means a big hit to revenue and earnings from investment banking at financials such as JPMorgan Chase (JPM), Goldman Sachs (GS), and Morgan Stanley (MS).

Fees from investment banking will be down because corporate finance activity—a bag that holds everything from new issues of debt to mergers and acquisitions—has been down this quarter. Thomson Reuters estimates that the third quarter will be the slowest for investment banking fees since the first three months of 2009.

Investment banking fees, which make up about 15% of investment banking revenue at these companies, will fall an estimated 43% from the second quarter.

Bad news for financials? You bet.

And for the other side of the earnings coin, look at the technology sector. Expectations are extremely modest—the sector trades at just 12 times projected 2011 earnings. That’s the same multiple as investors give the S&P 500 as a whole right now, even though technology stocks have historically traded at a premium.

Wall Street analysts expect that earnings per share in the sector will grow by just 10% in 2012. That sets the bar really, really low—projections call for 16% earnings growth for industrials and 14% for basic materials by comparison—making it relatively easy for the sector to deliver a positive earnings surprise.

And the sector sports an incredibly healthy balance sheet, with technology companies sitting on $700 billion in cash—second among the S&P sectors only to financial stocks.

I’d look to anything wireless, or anything that increases efficiency and cuts costs for company networks, to surprise on earnings this season. My short list would include (in alphabetical order) Apple (AAPL), Broadcom (BRCM), EMC (EMC), F5 Networks (FFIV), Marvell Technology Group (MRVL) and Nvidia (NVDA).

Or, of course, you could just buy the sector ETF. Again, that's the Technology Select Sector SPDR (XLK).

Full disclosure: I don’t own shares of any of the companies mentioned in this post in my personal portfolio. The mutual fund I manage, Jubak Global Equity Fund , may or may not now own positions in any stock mentioned in this post. The fund did own shares of Apple and EMC as of the end of June. For a full list of the stocks in the fund as of the end of June, see the fund’s portfolio here.

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